A troubling trend: in some jurisdictions, commercial general liability policies are essentially being converted into performance bonds.

In simpler times, it was universally accepted that commercial general liability policies did not cover contractor's liability for faulty workmanship. When insureds challenged this principle, the courts recognized that failure of the insured's work did not constitute an "occurrence" and/or "property damage," the underlying claim did not allege a fortuitous event and the "your work" exclusion expressly provided that this form of damage is not covered.

Over the past decade, however, business risk defenses have come under siege. With recent conflicting decisions, insurance professionals have been challenged to navigate a murky legal sea and the courts are now rife with construction defect litigation.

It all began with the introduction of the subcontractor exception to the "your work" exclusion. Pressured by contractors and brokers, Insurance Services Office amended the "your work" exclusion to include the following subcontractor's performance exception in the 1986 standard commercial general liability form: "We do not cover ... 'property damage' to 'your work' arising out of it or any part of it.... This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor." This exclusion has had broad, unintended consequences.

Certainly, there are situations where property damage to an insured's work has nothing to do with a subcontractor's performance. But due to the prevalence of subcontractors at major construction projects, and the expansive application of the subcontractor exception by some courts, the effect of the "your work" exclusion has been dramatically curtailed.

Linbach vs. Zurich (2005), issued by a federal appellate court, illustrates the lengths to which some courts have gone to invoke the subcontractor exception. The insured contractor, Linbach, had been hired to install an underground steam line at Howard University. During installation, Linbach's employees damaged the line. When the damage was later discovered, Linbach was sued for the line's faulty condition. Understandably, the CGL carrier declined coverage based on the "your work" exclusion.

Linbach argued that the supplier fabricating the steam line should be considered its "subcontractor;" therefore, the damage to the line fell within the subcontractor exception to the "your work" exclusion. The court agreed, requiring the liability insurer to indemnify Linbach for the flawed condition of the very line which it had been hired to install and which its own employees had damaged.

While some courts have been liberally expanding the subcontractor exception to the "your work" exclusion, others have been eroding remaining business risk defenses. For example, in Linbach, the court simply ignored the issue of whether the underlying claim for damage to the insured's own work had alleged an "occurrence."

In another recent decision, American Family Insurance vs. American Girl, the Wisconsin Supreme Court considered, but ultimately rejected, the traditional business risk defenses. There, the contractor/insured, American Girl, was hired to construct a warehouse. American Girl then hired a subcontractor to analyze soil compression. After completion, the warehouse began to sink and ultimately had to be demolished. Because the subcontractor's work had contributed to the damage, the court found that the "your work" exclusion did not apply.

The court then circumnavigated existing case law which had recognized that mere delivery of a defective product doesn't constitute an occurrence, by stating: "CGL policies generally do not cover contract claims arising out of the insured's defective work or product, but this is by operation of the CGL business risk exclusions, not because a loss actionable only in contract can never be the result of an 'occurrence.'"

Fortunately, although part of a troubling trend, the Linbach and American Girl decisions do not represent a majority view. Last year, the South Carolina and Nebraska supreme courts rejected arguments that faulty workmanship, even if performed by a subcontractor, could constitute an occurrence.

CGL underwriters do have a "silver bullet." In 2001, ISO released endorsement CG 22 94, eliminating the subcontractor exception to the "your work" exclusion and putting the parties back on the footing of pre-1986. Based upon an informal survey, about one third of new CGL policies issued to contractors contain this endorsement. It makes sense, particularly in jurisdictions where case law has essentially converted CGL policies into performance bonds, to consider broader use of this form.

Contributor William Stewart is national coverage counsel for law firm Cozen O'Connor. He can be reached at [e-mail].